Pressure to perform for stock market bearing down on disties

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The world's second-largest wholesale distributor of technology products, services and solutions, Tech Data, was not the first firm to restate its financial results – and it may not be the last.

But in a post-Enron world, with the associated heavy controls and accounting rules introduced after that massive accounts fraud scandal, to admit significant errors and lapses in control is not just embarrassing but can affect performance and damage credibility.

What may be worth exploring, though, is the reasons why controls and processes may have been unwittingly or deliberately bypassed and what pressures are influencing the people in control.

It’s worth exploring TD’s restatement as it gives weight to the argument that margin pressure and cost containment in broadline or volume IT distribution is so intense, it can lead to an environment in which the "human element" of process control or monitoring may be lost or weakened.

TD's restatement covered a period of some five years, from 2009 until 2013, a consequence of events that included material weaknesses in internal control over financial reporting within the company’s primary operating subsidiary in the UK and two other European subsidiaries.

It also covered inadequate control over manual journal entries in Europe and in two Latin American subsidiaries. Inadequate account reconciliation procedures in Europe over some aspects of vendor accounting and inadequate anti-fraud monitoring controls added to TD's problems.

The effect of restatement over the five-year period was quite significant. It resulted in reduced sales of $1.6bn; gross profit restated downward by $69m; increased SG&A costs of $41m; restated operating income down by $110m; and restated net income down by $45m.

The fact that volume distributors have to acquire to grow is patently obvious. TD sales between 2009 and 2013 increased by some $1.29bn but over the course of those five years, it acquired Scribona, Triade Netherlands, Man & Machine, SDG, DLI Portugal and entered into a joint venture with Brightstar before finally buying out Brightstar’s stake. The sum total of sales achieved by these acquisitions was estimated to be in the region of around $4.5bn. Indeed, in the nine month period to October 2013, SDG alone contributed some $1.6bn.

The distributor exited its Brazil and Colombia in country operations in 2012. Its reason for exiting was the complex legal, tax and regulatory environment, which failed to generate an adequate level of profitability and sufficient return on capital. It should be noted that in 2010, a Brazilian appellate court overturned a decision from 2003 where a court ruled in favour of the company’s Brazilian subsidiary, relating to certain taxes on payments abroad and in relation to licensing of commercial software products, referred to as CIDE tax. The distie's exposure to this tax, including interest, was considered to be approximately $29.7m as at January 2013.

Tax issues in Spain relating to VAT resulted in an increased provision of $41m in the year ended January 2013, bringing the total to around $55.6m. VAT issues may be complex but often come about because of misunderstandings regarding local taxation, regulatory and insolvency rules and lapses in anti-fraud processes and money laundering activity monitoring. Suppliers, for example, have a responsibility to monitor and asses the activity of clients to ensure compliance.